Maybe a Retirement Compensation Arrangement could be your way to a flexible pension plan.
Demographics dictate that as many as 80% of small business owners will
either sell or pass on their businesses to heirs over the next 10 to 15 years. There are many ways to free up a significant amount of the wealth
tied up in your business, but how do you complete this transfer and incur the least amount of tax?
“Owners of small manufacturing businesses are generally experts in their fields but likely unaware of the intricacies of orchestrating a tax efficient sale,” says Michael Soble of the Reynolds Soble Group at CIBC Wood Gundy. “And they may not have a professional advisor, like a lawyer or accountant, who is familiar with all of the options”.
One often-overlooked strategy is the use of a Retirement Compensation Arrangement (RCA). Properly structured and implemented, it will drastically reduce the overall tax impact of a sale and provide a creditor-proof, flexible and tax-efficient pension plan.
Business sales typically involve assets or shares. Most owners prefer to sell the shares and gain access to the $750,000 lifetime capital gains
exemption, while purchasers prefer buying the assets. The tax treatment on each type of sale is different, but an RCA is particularly useful when the
sale involves the assets.
The rules surrounding the establishment, funding, ongoing management and withdrawals from an RCA are complex, but to summarize: an RCA is established under the rules of the Income Tax Act, and allows a company to make tax deductible contributions on behalf of key employees to build a retirement pension. The contribution guidelines are generous (compared with RRSP
limits) and actuarially determined based on income and years of service.Funds are not locked-in as they would be in a normal pension plan, they are creditor protected; withdrawal rules allow for flexibility in terms of timing and amounts; and there are few investment restrictions. “The bottom line is that once the RCA is reasonably funded (which can be from the proceeds of a sale of assets), there is a great deal of flexibility as to how the money can be invested, the amount and the timing withdrawals, and even passing along RCA assets to spouses and other beneficiaries,” says Soble.
Here’s a simple example. Assume the following:
– Business assets sold for $3, million net proceeds.
– A $3 million RCA contribution is determined to be reasonable under Canada Revenue Agency guidelines.
– If there is no RCA, the owner will bonus this out, pay tax personally and invest the remainder.
– Investments earn 5% annually.
– The owner requires $190,000 per year, net of taxes, for the next 10 years from
his investments, or from the RCA.
With no RCA, sale proceeds are $3 million, personal taxes (Ontario) are almost $1.4 million (46%), Ontario payroll tax is $58,500 (1.95%), the
balance after tax is almost $1.6 million and annual withdrawals are $190,000.
With an RCA for one, there are no personal taxes and no payroll tax with a balance of $3 million and annual withdrawals are $190,000. Same for an RCA that adds a spouse, both in after-tax dollars. But the gross that must be withdrawn from the RCA each year is higher since it’s subject to full
taxation. For a one-employee RCA, withdrawal of $321,486 less tax of $131,486 = $190,000 net. With no RCA, withdrawals are mainly from after-tax
income. After 10 years, the balance for no RCA is $67,322, $334,504 for a one-employee RCA and $704,096 for an employee plus spouse.
(The employee plus spouse RCA assumes equal T4 income from the company over
“We are seeing more opportunities for RCAs pop up in connection with business owners as they start to actively plan for selling their
businesses,” says Mike Reynolds.
Establishing an RCA is complex and requires specialist input in the areas of tax, actuarial review, accounting and investment management, so there has to be enough dollars involved to make it worthwhile. However, the potential benefits are huge: immediate and future tax savings; significantly increased
retirement income; and estate planning flexibility in the future.
Mark Borkowski is president of Toronto-based Mercantile Mergers &
Acquisitions Corp., which specializes in the sale of mid market companies
sold to international strategic and private equity firms. He can be contacted at firstname.lastname@example.org
The Reynolds Soble Group – CIBC Wood Gundy.
Michael Reynolds (416) 369-8742
Michael Soble (416) 369-7769